Q4 2022 Arrow Electronics Inc Earnings Call
Good day my name is Rob and I'll be your conference operator today at this time I would like to welcome everyone to the Arrow Electronics first quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there will be a question and answer session. If you'd like to ask a question. During this time simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question again press the star one.
Rick Silent you may begin your conference.
Thanks, Rob.
Good day and welcome to the Arrow electronics fourth quarter and full year 2022 earnings conference call with US on the call today are Sean Kerins, President and Chief Executive Officer, and Raj Agar Wall, Senior Vice President and Chief Financial Officer.
During this call we will make forward looking statements, including statements about our business outlook strategies and future financial results, which are based on predictions and our expectations as of today.
Our actual results could differ materially due to a number of risks and uncertainties, including the risk factors in our most recent 10-K and 10-Q filings with the SEC.
<unk> undertakes no obligation to update publicly or revise any of the forward looking statements as a result of new information or future events.
As a reminder, some of the figures we will discuss on today's call are non-GAAP measures. We have reconciled those to the most directly comparable GAAP financial measure measures in our earnings release.
These non-GAAP measures are not intended to be a substitute for our GAAP results.
Can access our earnings release at Arrow at Investor Arrow Dot Com, along with our CFO commentary the non-GAAP earnings reconciliation and a replay of this call.
Following our prepared remarks today, we will be available to take your questions I will now hand, the call to our president and CEO Sean Kerins.
Thank you Rick and thanks to all of you for joining us today.
Before I talk about our most recent results I wanted to reflect a bit on the past year in total which continued to present arrow with unique market conditions and challenges.
It was truly special to lead this great company and our 22000 dedicated employees as we met those challenges head on and helps both our customers and supplier succeed in this environment.
In turn we have delivered the strongest financial result of any year in the history of the company and while I'm extremely proud of what we've accomplished I know that the market conditions continue to evolve as we enter 2023 will be faced with new challenges and opportunities through which <unk> will continue to differentiate itself in the markets we serve.
Reflecting the commitment strengths.
And aspirations of our entire global team.
Now turning to our results I'm delighted to report that the fourth quarter was in line with our expectations.
One of our best quarters ever despite some challenging conditions are.
Our sales grew by 8% year over year on a constant currency basis fueled by both growth in our global components and our global enterprise computing solutions businesses.
In our global components segment sales grew 6% as compared to last year on a constant currency basis, while demand for electronic components and associated design engineering and supply chain services generally remained healthy in the west we did experienced softer demand in Asia relative to our sales guidance, especially in.
China, it's important to remember that we are not too concentrated in any one area. We're proud to service a variety of industries and provide products from a diverse group of suppliers.
To a diverse group of customers around the world. Additionally, design and engineering capabilities remain a key part of our strategy and our ongoing investments continue to contribute to our success in all three regions.
As we discussed last quarter supply and demand conditions have been moderating somewhat however, we are comfortable with our near term outlook based on the quality of both our inventory and our backlog while conditions may continue to moderate as we enter 2023, we remain focused on helping our customers.
Secure the products they most need.
Both the Americas and European regions produced strong year over year growth as both regions experienced healthy demand across several major end markets and industries, particularly industrial transportation.
Aerospace and communications.
In the Americas, we are continuing to see normalization in our shortage market services as supply continues to improve this contributed to the sequential sales decline in the Americas.
Was the primary driver for margin compression in our global components business overall.
Sales in our Asia region declined due to weakening demand in most end markets. We believe demand will likely remain soft in the near term as the region recovers from Covid related disruptions and market headwinds. Despite the sales decline in the fourth quarter design activity was quite robust and will no doubt contribute to our longer term prospects in the.
<unk>.
With our diverse portfolio of customers and suppliers along with our differentiated services offerings. We believe we are well positioned for when the market in this region eventually recovers.
In the enterprise computing solutions business, we delivered year over year sales growth for the third consecutive quarter.
Sales for the fourth quarter grew 12% year over year on a constant currency basis and finished above the high end of our guidance.
Hardware supply constraints are easing somewhat and demand remains strong for most of our key technology categories.
We continue to see strength in cloud.
Software and enterprise it content and are well positioned for the transition to <unk>.
As a service.
In Europe , we experienced strong growth in all of our markets and technologies in the Americas. Our growth came primarily from strength in security compute and infrastructure software. We continue to measure this business on operating profit growth and we are pleased to report full year growth of 4% year over year.
Before handing over the call I want to reiterate my confidence in our ability to help our customers and suppliers meet the challenges that lie ahead.
While supply and demand conditions may continue to moderate over the coming quarters. We believe that will retain much of what we achieved over the past few years in terms of scale capabilities and an improved margin profile will continue to help our customers and suppliers and in doing so we are confident that we will continue to generate.
Attractive returns.
With that I'll now hand, the call over to Raj to provide more details on our results and our expectations moving forward. Thanks, Sean fourth quarter sales grew by 3% versus prior year or 8% on a constant currency basis changes in foreign currency impacted sales growth by approximately 350 <unk>.
$9 million year over year, which was less than our expectation of $420 million.
Sequentially the business grew by 1% and currency impacts were minimal.
Average Euro dollar exchange rate for the quarter was 102 to one euro compared to our previous expectation of <unk> 90 to one euro.
Fourth quarter gross margin of 12, 9% was down 40 basis points year over year, driven mostly by the normalization of shortage market activities, we began to see in the third quarter.
Sequentially, our margins improved by 10 basis points due to favorable product mix and the enterprise computing solutions business.
Operating expenses as a percent of sales were seven 2% down 20 basis points year over year, and 10 basis points sequentially.
Interest and other expense of $62 million has significantly increased year over year and sequentially due to higher rates on floating rate debt and higher borrowings that was in line with our prior expectations.
The effective tax rate for the quarter was 24, 8% this was slightly higher than our prior expectation of 23, 5% due to timing of certain items within the year.
For the full year, our effective tax rate was 23, 8%.
Both the fourth quarter and full year rates are within our long term range of 23% to 25%, which we continue to see as our appropriate target range going forward.
Turning to cash flow and the balance sheet, our fourth quarter operating cash flow was $109 million, our cash cycle of approximately 66 days increased three days from the third quarter and 12 days year over year, primarily due to inventory increases which are largely related to pricing.
As a reminder, our inventory investments allow us to support customer demand and we have continued to generate strong returns in the process are.
Our return on invested capital and return on working capital remained well above pre pandemic levels.
At the end of the quarter net debt totaled $3 $6 billion and our liquidity remains very strong at approximately $2 3 billion.
Including cash of $177 million.
Our strong financial position and flexible balance sheet positioned us to repurchase $300 million of shares during the quarter at the end of the fourth quarter our repurchase.
Our remaining repurchase authorization stood at $329 million were also pleased to announce that our board of directors has approved an additional $1 billion to our share repurchase authorization returning cash to shareholders through our stock repurchase plan remains one of our priorities and this authorization reflects our commitment.
Please keep in mind that the information I've shared during the call today is a high level summary of our financial results.
For more detail regarding the business segment results. Please refer to the CFO commentary, which we published on our website. This morning also noted the CFO commentary includes information on our fiscal calendar closing dates.
Now turning to guidance mid point sales and EPS guidance reflects a continuation of current market conditions, which we have discussed, particularly the impacts of normalizing charge market activities.
Midpoint global component sales reflects an expected decline of 7% compared to prior year and 5% on a constant currency basis.
Our forecast suggests enterprise computing solutions will grow 3% year over year, and 6% on a constant currency basis.
We estimate that the strengthening of the U S dollar compared principally to the Euro will result in a reduction to sales growth of $182 million and EPS growth of 13 compared to prior year.
Compared to the prior quarter, we estimate that the impact will be a positive $175 million to sales and 11 to EPS.
I will now turn the call over to the operator for Q&A.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad.
Our first question comes from the line of route <unk> Bhattacharya from Bank of America. Your line is open.
Sean I wanted to start with a high level question I mean, when you look at end market demand today versus 90 days ago. I mean, how would you say I mean are things materially weaker are they the same or how do you see that trending over the next quarter and then specifically on the component side I think you said bookings were below parity.
In all regions.
Concerning and do you think backlog will continue to decline or do you think that that can also grow over the next couple of quarters.
Sure Group Lou let's start with just our feelings about the market overall and I would say, it's sort of mix.
If you look at our guide for the first quarter, we're basically at or above normal seasonality in all of our western markets.
So maybe not quite as broad based in the west as it was maybe 90 days ago, but we're still seeing activity levels and things like transportation industrial aerospace and defense and medical device sector is holding up.
Certainly other sectors like compute communications consumer.
And things like lighting slowing down.
Obviously demand trends in Asia.
Specifically, China had been impacted by <unk>.
Market headwinds and Covid disruption.
It obviously was initially all about consumer and PC, but that's now bled into other key verticals as well.
But by and large we still see.
Enough activity in the west to feel good about our outlook in the first quarter.
And to that point your question about backlog look our backlog is down from its all time high, but it's still well well well beyond historical levels our teams do.
A pretty good inactive job throughout the world to continue to validate that backlog.
We believe.
The majority of it is still firm versus forecasted and that work yields or has yielded certainly more rescheduled and push outs and cancellations. So we feel pretty good about the backlog and as we said earlier the quality of our inventory to support the guidance we shared.
Okay. Thanks for the details there Sean maybe I can ask Roger a couple of quick questions.
On the on the inventory it looks like sequentially. It was up 5% I know youre guiding you know theres some seasonality in the March quarter, but can you just talk about like what drove the increase in and as you think about this year in free cash flow and working capital days, how should we think about that going getting inventory.
Means high for a while or do you think that we're at the plate networks. It's peaked and it can it can actually come down and free cash flow can be better.
Yes, I would say the majority the majority of the increased inventory, whether it's quarter over quarter or year over year is driven by pricing environment that we've been in and so that's really what's driving it.
We do as Sean said earlier, we have a good strong backlog, we think we can sell through most of the inventory and.
It's hard for me to say, what the peak levels cannot be APAC. We continue to have good demand in the west and Thats really what were looking at.
And from a cash flow standpoint, I think we're going to generate some cash flow. This year, just given the market dynamics, but overall, we feel good about where we sit.
And I would just add some color to that which is.
Look I look at inventory as a function of customer service.
Especially in this environment so.
We really spent as much time as we can to help our customers deliver on their production schedules.
Even as they change and as you might imagine there is a fair bit of change in this environment, but.
Look at the increase in Q4 for example, I would call. It for the most part modest but I think a healthy inventory investment now.
Will set us up for attractive returns in the future.
Okay that makes sense.
Finally, if I could just ask I think.
One concern that many investors have as you know our margins at their peak.
As suppliers lower their prices I mean, when you see ASP pressure and how you think about margins and in that context. If you can give any any of your views on how you think margins can trend, but also do you have cost levers and I guess my question is on general risk management like if we go into a recession.
Or a slowdown.
Do you think opex as a percent of sales or as a percent of gross profit still has.
You have levers to lower that meaning you can take more cost out so just thoughts on your ability to manage your costs and how you think margins will trend.
Maybe in a deflationary environment.
Recessionary environment. Thank you thanks for all the details.
Sure <unk> so of course, I always like to talk more about growth and cost, but I'll start with the.
The second part of your question, we feel like our Opex is fairly well managed as you can see we we landed at historical lows on both the percent of sales as a percent of gross profit basis.
We've got all kinds of levers in place to make sure that we're protecting our investment priorities.
And continuing to work on.
Structural cost overtime, you were obviously going to be very surgical in this environment. If things were to slow more dramatically I think we know where to go and remember that.
Variable cost.
In a more recessionary environment would come down substantially I think to the first part of your question and it's the right. One we spend a lot of time looking at.
How the complexion of our business has changed over the past couple of three years and.
As the supply demand market continues to normalize I can tell you that we feel pretty confident about our ability to retain some of the structural benefits that we built into our model. So I can't sit here today and say exactly when the market will fully normalized but it will and we will reach something that we might call a steady state.
When we do I am confident that operating margins in our components business theyre going to land well north of the last long term target, we set for that business and for those of you that maybe werent as involved.
That was 5% at the time I think now we're looking at something in the range of five 5% all the way to maybe six points.
So.
The reason we have conviction around that is because of the structural investments we've made over time and.
I could talk a lot about engineering resources that help us capture design win margin potential. We think there's still runway there I can talk about supply chain capabilities and what that's doing to help us serve our customers in different and value adding ways.
I can talk about design services, which are especially interesting too.
Some of our larger OEM customers for which we enjoy.
Really accretive returns.
So there is some real thought behind that statement and I think.
While you might want to ask me when and.
We won't commit to a timeframe again, the market's got to normalize, but we feel really good about.
The next target range for that business.
Okay. Thanks for all the details appreciate it that's helpful.
Your next question comes from the line of Matt Sheerin from Stifel. Your line is open.
Yes. Thank you.
Hey, good afternoon, everyone.
Yes.
A little bit more color in terms of what youre seeing it sounds like the western markets are holding up better.
Competitor last night.
Seeing a below seasonal demand in all regions, although like you I'm, calling out in Asia.
The weakest area.
Theyre seeing an inventory correction start to play out across their business and it doesn't sound like youre seeing that yet.
Are there any other than your commentary about.
Some push outs and no cancellations.
Anything else you are seeing there are you book to bills are going negative in those markets.
Well.
As I think maybe the CFO commentary, where someone suggested book to bills are below parity in all three of our regions, but maybe I'll go back to what I, what I shared about the guide again in most of our western markets, where we're at or above normal seasonality in our Q1 outlook, China really is the only place where.
We're sub seasonal here.
From an inventory perspective as I mentioned.
I never like to see it creep up but I have confidence in what it will help us deliver.
Our Asia Pac team.
Funny enough kept inventory flat sequentially quarter over quarter. So we are managing that as well as we can under the circumstances, especially why we try and juggled.
The balance between working capital and customer service.
I think we're in we're in pretty good shape on that front moving forward.
Okay.
In components, you talked about weakness in that shortage market.
In North America.
Which makes sense.
Do you think that's bottomed.
The fundamentals there or is that gotta get weaker before it bottoms.
Matt I think we're getting closer I think we will still see some of that pressure in Q1.
But then I think we will see that become less impactful over the balance of this year, assuming all else remains equal.
Okay, Great and just a question on ECS, where it looks like you've had nice strong results.
Good demand drivers.
Our hearing.
Some concern about the backlog and as that.
Billed as component.
Sure.
Get easier.
The backlog.
Working lot and power.
Are you seeing that in any of your businesses or do you have any kind of outlook in terms of it spending for the year and as Youre talking to your customers.
Sure maybe I'll start with your question about backlog I think in my opening comments I talked about the fact that the.
The hardware supply chains are easing somewhat it hasnt completely flushed.
And our backlogs are still close to all time highs in that business. So there is still a ways to go but it was nice to see some relief.
In the fourth quarter, and I think we will see.
Some relief throughout the year I think the broader market, while it was rebounding from.
The pandemic I think is maybe moderated somewhat.
At least call it mix.
Talked about supply chains.
Cloud adoption is slowing somewhat at least from its pandemic levels.
Given some recessionary concerns we have seen some evidence of.
Slowing sales cycles surrounding enterprise it more generally but at the same time pipelines related to cyber security infrastructure software things like digital automation. They are all still pretty active and healthy so well.
While we're not super bullish about the growth outlook for the year by no means do we see it going south.
Okay, great. Thank you.
Your next question comes from the line of Jim Suva from Citigroup. Your line is open.
Thank you, Sean Sean before you're at Arrow and before Covid. There were some supplier consolidation some supplier changes about using distribution not using distribution, giving more value added demand creation, giving less value added creation to the distributors I'm just wondering.
Now that hopefully if we exit COVID-19 and hopefully get to more normalized supply chain are you seeing are having discussions with suppliers for any changes and are they.
Positive negative or no changes I'm wondering if there's actually more opportunity or is there like more consolidation or kind of what's going on because the past three years have been challenging for everybody. Thank you.
They certainly have thanks, Jim So maybe maybe take your question in a couple of pieces I mean first from a consolidation perspective, that's a little tough for us to call.
Consolidation will likely continue in the industry, but we don't have.
Any specific knowledge of anything.
In play we've tended to benefit from some of that and at times, maybe get hurt from some of that so that one's a little bit tough to call.
But from a program perspective look we're always having conversations with our suppliers. Our suppliers are always looking at ways in which they can work with us to rely on more of our capabilities.
I would say in general not less.
I do believe theres more demand creation potential in the overall semiconductor supplier market in total.
So our demand creation mix.
Improved year over year.
We look at design activity every quarter pretty closely throughout the world and we see design registrations and design wins still going up.
So while you might from time to time catch wind of a supplier that is looking to trim.
The margin profile in their channels.
I'm comfortable that Theres plenty, that's still place a lot of value on.
The engineering investments, we make for demand creation.
Give us a chance to be rewarded accordingly, so I think the.
The outlook for that particular piece of the question is still is still very valid and very promising.
Thank you so much for your details congratulations on good results in such a challenging time. Thank you.
Thanks, Jim.
Your next question comes from the line of William <unk> from <unk> Securities. Your line is open.
Great. Thank you for taking my question.
Okay.
First I'd like to ask about the trend in lead times broadly I think it's pardon.
Pardon me I think it's clear that they are coming down, but I wonder where you think we are in that normalization process are we somewhere in the middle innings or are we still in the beginning of that process would you expect that to continue throughout the year and then I have a follow up.
Hi will.
It's funny, because I think you read some headlines specific to certain components of the technology mix.
People broadly assume all of the supply constraints have gone away, but we still see it as very mixed I mean lead times have come in in certain cases, but on average.
The lead times, we see across.
Our whole electronic components business is twice.
The pre pandemic average now thats down from some of the higher levels at once sat at but it is still not sufficient to satisfy.
The backlog that we still see so I call it mixed on a technology basis.
Good to say when it all fully normalizes.
See that happening.
Probably anytime soon maybe it will gradually improve throughout the year don't know, we really don't want to speculate too far ahead.
The quarter in front of us and maybe just a little bit more.
Remember all the capacity.
<unk> investments that we've read about over the past couple of years that takes time to materialize it.
It really changed the structural.
Supply formula for the industry in total so I think it's still going to be.
Mixed in.
It's going to be a little bit of an ebb and flow here over the course of the year, but we're going to focus mainly on what we can see over the next 90 plus days.
Okay. Thank you.
As a follow up.
Arrow has a.
Well known significant supplier.
Went through a consolidation process with distribution partners I think a couple of years ago now.
But they've been pretty aggressively deploying some.
Sure.
Features in there.
Sort of supply chain, if you will.
For example, our new distribution center in Europe , where there where theyre doing same day delivery.
It can help these API is for customers to have directly into their website.
I wonder if.
Seems relatively clear that this is targeted at the types of services that you have provided to their customers or to get into your customers over the years I Wonder if you see this as.
As the threat that sort of materializing to that portion of.
Of your revenue today, or if it's something in the future or if you could just.
Don't think that this is going to have a meaningful impact on your business. Thank you.
Yes, well you know.
Look I'm not going to claim maker, it's here, but yes, I think you can appreciate we would never talk about any of our suppliers in particular.
So.
Can't really help you out a whole lot with that one I can say that overwhelmingly as I said earlier most of our conversations with most of our suppliers are all about how we can help them do more so I feel pretty good about what that means for us not just now but into the future.
Thank you.
And again, if you would like to ask a question Press Star then the number one on your telephone keypad. Your next question comes from the line of Joe Quattrochi from Wells Fargo. Your line is open.
Yes, thanks for taking the questions in the past you guys have talked about kind of a customer survey on the number of customers that don't have enough inventory or have too much inventory is there any color you can provide on where we stand in that kind of results of that survey.
Yeah.
Sure Joe I guess, the short answer is mixed.
We continue to perform the survey and of late it's been really hard to see any consistent patterns.
You'll see the numbers move around a little bit little bit one quarter to the next for those who say they have too much versus those they have say they have too little and then youll see it move again in the other direction.
In Q4, so I would not place a whole lot of stock and what that's telling us in this environment. Because this is such an abnormal.
Supply environment, So, it's a little less predictable for us.
Relying on lots of other vectors that we have access to including our backlog in.
And including our inventory turns et cetera.
Okay. That's helpful. And then on the share repurchase program that you guys announced is there an exploration to that authorization and then how do you think about balancing that activity relative to your working capital need just given the increase in short term borrowing rates that we've seen kind of filter into.
<unk> expense line.
Hey, Joe This is Raj there is no exploration to that sure.
Share buyback authorization, which is similar to what we've done in the past are no change there.
And our capital priorities continue to be assignments that with we have a need to invest in the business that will be our first priority.
And then we always are looking for the right kind of M&A opportunity at good returns.
To the extent, we have excess capacity or buyback our stock and that's really what we've been doing.
And then in terms of short term rates and we've taken that into account.
Certainly driven our interest expense in the fourth quarter, but they are the things that we're doing more than pay for that incremental costs or I think we're positioned well.
Got it thank you.
Sure.
And there are no further questions at this time, Mr. <unk> I'll turn the call back over to you for some final closing comments.
Alright. Thank you Roger I just want to thank everyone for your interest in Arrow electronics and wish you have a nice day. Thank you.
And this concludes today's conference call. Thank you for your participation you may now disconnect.
Please wait the conference will begin shortly.
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